Leverage and the Financial Accelerator in a Liquidity Trap
Mertens, Karel, and
Morten O. Ravn. 2011. "Leverage and the Financial Accelerator in a Liquidity Trap."
American Economic Review,
We show that the financial accelerator may be very large in a liquidity trap. We study a sticky price model with real estate and a financial friction specified as a collateral constraint. Expectations can lead the economy to a self-fulfilling liquidity trap equilibrium where the lower bound on the nominal interest rate binds. We model these equilibria as stochastic sunspots. As in the Great Depression, a liquidity trap entails house price depreciation and potentially large output losses. Higher leverage implies much larger output losses but at the same time rules out the existence of short-lived liquidity traps.
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Mertens, Karel (Cornell U)
Ravn, Morten O. (U College London)
D84: Expectations; Speculations
E32: Business Fluctuations; Cycles